Term Conversion

Client situation:

• 78 year-old female


• $1,000,000 15-year level Term Policy; two years left for conversion option to Universal Life Policy


• No Cash Surrender Value (term insurance)


• Upcoming Annual Premium $10,000


• Insurance no longer needed for debt coverge (mortgage). Client (insured) desires to reallocate funds from premims for unnecessary policy

The Settlement Process:

• Client case file compiled: in-force illustration for post-conversion Universal Life Policy


• Offers from Funder's: $190,000 to $220,000


• Subsequent negotiations result in final high offer of $250,000 (client accepts offer)


• Transfer of ownership contracts processed/executed


• Settlement funds are wired to the policy seller (net of disclosed compensation fees)


• Upon expiration of rescission period (normall 3 - 15 days) compensation is wired to the agent/broker

Fundemental Life Settlement

1. Client situation:

• 75 year-old male


• $2,000,000 Face Value Universal Life Policy purchased 5 years ago


• Cash Surrender Value of $50,000


• Upcoming Annual Premium $60,000


• Change in financial situation: Estate tax changes reduced need for coverage and as a result the client (insured) does not want to pay escalating premium any longer

The Settlement Process:

• Client case file compiled: HIPPA, medicals/APS, In-force Illustration, Life Expectancy reports, Application, which is sent to multiple Funder's for evaluation and pricing offers


• Received 4 initial offers ranging from $360,000 to $380,000


• Subsequent negotiations result in a final high offer of $460,000


• Client reviews highest offer and decides to accept the offer


• Transfer of ownership contracts are then processed and executed


• Coverage is verified at the Life Insurance carrier


• Escrow


• Policy ownership is transferred and recorded at the Life Insurance carrier


• Settlement funds are wired to the policy seller (net of disclosed compensation fees)


• Client uses proceeds fro retirement funding, smaller Insurance Policy


• Upon the expiration of statutory contract rescission period (normally 3 - 15 days) compensation fees are wired to the agent/broker

Tax Implications of Life Settlements

At the time of this writing, there are no Internal Revenue Code provisions or IRS rulings pertaining specifically to the income taxation of life settlements. Many authorities use the following assumptions in calculating the projected tax liabiltiy:

• If the seller's policy cost basis (the total amount of net premiums paid) is higher than the life settlement amount, the seller will not realize any taxable income from the transaction

• If the life settlement amount is higher thant the seller's cost basis, the excess of the policy's cash surrender value at the sale date over the seller's basis is a taxable gain. It is unsettled whether the gain is treated as ordinary income and taxed at the seller's marginal tax rate or is treated as a capital gain.

• If the policy has no cash surrender value, or the surrender valuse is less than the policy's cost basis at the date of policy sale to the provider, then consistent with the assumption posed above, the excess of the settlement amount over the seller's cost basis could be treated as a taxable gain (ordinary income or capital gain, depending on the position the IRS takes).

This projected tax liability should be calculated by the seller's tax advisor as part of the initial life insurance versus life settlement "trade-off" evaluation, and certainly taken into account before accepting a life settlement offer. Also, it should be pointed out that the tax consequesces to the policy owner/seller receiving a cash payment during the insured's lifetime are not as favorable (or certain) as that of receiving the policy's death benefit.

Ethical Gidance:

In considering a life settlement, a life insuracne agent, attorney, accountant, or trust officer is expected to soley represent the best interests of the policy seller, regardless of the manner in which the advisor is compensated. Also, an advisory team is an approvriate collaborative tool that can better assure objectivity, client focus, and informed, fully disclosed decisions.

Tax Facts - Ethics copywright 2006 The National Underwritier Company

Life Settlement Case Study

Client Situation:

• 75 year-old male
• $5,000,000 Universal Life Policy purchased 5 years ago
• Cash Surrender Value of $125,000
• Upcomming Annual Premium $150,000
• Change in financial situation: Estate tax changes reduced need for coverage. Insured does not want to pay escalating premium any longer

The Settlement Process:

• Client case file compiled: HIPAA, medicals/APS, in-force illustration, LE report, application and sent to multiple Institutional Investors (Funders) for evaluation and pricing offers
• Initial offers received ranging from $900,000 to $950,000
• Subsequent negotiations results in a final high offer of $1,150,000*
• Client reviews highest offer and decides to accept offer (*less intermediary fees)
• Transfer of ownership contracts are then processed and executed; coverage is verified at the carrier; escrow; policy ownership is transferred and recorded at the insurance carrier
• Settlement funds are wired to the policy seller (less agreed upon intermediary fees). Client uses proceeds for retirement funding, smaller insurance policy
• Upon the expiration of statutory contract rescission periods (3-15 days), compensation is wired to the intermediary

Typical Life Settlement Characteristics

• Financial situation/needs change effecting insured (see label - When Appropriate)
• 65 years and older; average mid-to-late 70's
• Life expectancy greater than 3 years to approximately 17 years; average is about 10 years (no terminal illness or chronic/catastrophic conditions)
• Policy types - 1. Universal Life policy's are most common 2. Survivorship 3. Term (convertible) 4. Whole Life
• Carrier has a BB rating or better
• Policy face value minimum - $250,000
• Policy is beyond the contestable period (2 years)

Benefits to Insured

• Provides insured with alternatives not previously available
• Competitive marketplace (fair market value)
• Provides added value to life insurance policy at the time of sale
• Settlement revenue provides resource for insured to purchase newer, more appropriate coverage, invest, long term care, etc.

Life Settlements Should be Considered When:

• Financial plans change for the insured


• Reason insurance was originally purchased is no longer applicable


• Dependent(s) status change (divorce/death), are grown, or do not need coverage


• Policy's are under-performing


• Insured's insurance needs require new, more appropriate coverage


• Business changes ownership or key executives change


• Insured needs exit strategy for advanced planning insurance programs


• Seeking a tool to fulfill charitable gifting needs


• Changes in estate tax laws


• Insured becomes self-insured


• Change in estate value